Many chartists use multiple moving averages and use the cross-over of these averages to generate or to confirm buy and sell signals, which we had discussed in our previous Tech School.
Moving averages (MA) can be used to identify the point at which a position (buy/sell) can be initiated and the duration for which the position can be held on to. In other words, these technical tools help an investor to stay on the right side of the trend for as long as possible.
A buy is signalled when the stock’s closing price crosses above the moving average from below after a down-trend.
A sell is generated the stock’s closing price moves below the moving average from the top after an uptrend.
As long as the stock price is above the MA the trend is defined as bullish. In the same way, as long as the stock price is trading below the MA, the trend is defined as bearish.
When using multi moving average lines with different time frames, the buy and sell signal or the identification or confirmation of trend reversals are done when the fast (such as 21-day SMA) moving average crosses the slower (such as 50-day SMA) moving average.
This crossing of moving averages is called moving average crossover.
In chart-1 of ABB the stock price crossed below the 21-day moving average (thin line) in mid-January, indicating sell (see box). The 21-day moving average crossed below the 50-day moving average (thick line) from the top (see circle) a little later, indicating the end of the uptrend and the beginning of the new downtrend.
Chart-2 of Piramal Healthcare depicts signals generated by moving averages in an up trend.
In August 2007, the stock price crossed above the 21-day moving average, indicating a buy (see box). Subsequently the stock began to trend upward, the 21-day moving average crossed over the 50-day moving average (see circle) confirming the end of downtrend and the commencement of a new up-trend.
In case of stocks in a non-trending or sideways consolidation phase, the multiple moving averages are difficult to implement .